Raising interest rates may be a positive signal
Despite further weakness in Chinese trade data, with sharp falls in the value of both imports last month, markets stabilised with the Hang Seng returning +3.47%, S&P 500 +2.13%, MSCI Europe ex UK +0.50% and MSCI United Kingdom +1.27%. Japanese equities had their biggest one day gain since October 2008 when the Nikkei 225 rose 7.7% following Shinzo Abe, the prime minister, pledging to cut corporation tax by at least 3.3% next year, providing confidence to investors that further measures of stimulus could be on its way. Over the whole week, the Japanese Nikkei 225 rose 2.65% in yen terms. The statement that markets reacted to the strongest over the week were ones made by Kaushik Basu, the World Bank’s chief economist who said the Federal Reserve (Fed) risked further “panic and turmoil” in emerging markets if the US raised interest rates this month which led to a strong intra week rally.
There is much anxiety being caused by the first potential US interest rate rise since 2006 and credible arguments are being voiced both ways. In our view, the ability to raise interest rates would actually be a positive signal for the strength of the US and the global economy whilst the drawn out uncertainty over US interest rates is leading to a steady outflow of assets from emerging markets. An earlier interest rate rise followed by communication that rates will only rise very gradually may actually be a better outcome for emerging market economies and the global recovery. However, currently Futures markets are pricing in a less than a 30% chance of an increase at this week’s meeting.
The Bank of England left interest rates on hold at 0.5% as widely expected and the Monetary Policy Committee cited rising external risks to their third quarter GDP forecast, in particular the weakness in China.
Eurozone revised GDP for the second quarter moved higher from 1.2% to 1.5% bolstering sentiment in Europe’s economic recovery.
On Thursday the Fed will announce its long awaited decision on interest rates. This is a very finely balanced decision and arguably too difficult to call though the market has increasingly signalled that it expects interest rates to remain at 0.25%. The Fed will also update their longer term projections and the expected rate of travel for future interest rate rises. This is significant as current Fed projections are notably higher than market expectations and any move down is likely to be taken positively. Ahead of this, August data for US inflation is released on Wednesday and retail sales and industrial production data on Tuesday. Consumer prices are expected to remain unchanged at +0.2% from July. Lower energy costs are expected to have contributed to a 0.3% gain in retail sales versus July whilst industrial production is expected to have slipped 0.2% following a strong reading in July.
Over the weekend data out of China showed that both retail sales and industrial production had risen in August at a faster pace than in July, but nonetheless both weak when compared to previous years. Fixed asset investment declined in August year on year and also lagged expectations. Nonetheless, there are hopes that the Chinese economy may have bottomed in the short term and further stimulus could be on its way. The Shanghai Composite index is now down 40% from its seven year high reached in June.
UK inflation data is released on Tuesday, with the CPI expected to have risen to 0.1% year on year.